7 minute read
Many successful entrepreneurs dedicate a large amount of their profits to charitable pursuits, and the importance of supporting charitable causes seems to be increasing in these households. According to The 2021 Bank of America Study of Philanthropy: Charitable Giving by Affluent Households, 8 out of 10 households with net wealth of $200,000 or more donate annually to charity. That number increases to 88.1% for high- or ultra-high-net-worth households. High-net-worth individuals in particular tend to set up foundations, donor-advised funds and charitable trusts to further their philanthropic interests. In fact, in 2020, high-net-worth individuals donated on average $43,195 to charity.
There are many reasons that high-net-worth households are interested in charitable giving. While tax advisors often encourage their clients to make charitable donations for the tax benefits, most affluent individuals who make charitable contributions are driven by more altruistic reasons. Those who make large donations say they are motivated by:
Because tax benefits alone are not a driving factor for making contributions to charity, philanthropic giving is often unstructured. These households could benefit from better structuring and planning for their philanthropic efforts and contributions to go further and have a greater impact.
There are multiple strategies that affluent households can turn to in order to reduce their tax bills, maximize their charitable contributions and, in some cases, shift assets to younger generations while minimizing estate and gift tax implications.
1) Private Foundations
A private foundation is formed when an individual or household sets up a tax-exempt organization but does not file to be recognized as a public charity. Because the foundation is not a public charity, tax deductions for donations to the foundation will be limited to 30% of the taxpayer’s adjusted gross income (AGI) if the gifts are made in cash, or 20% of AGI if the gifts are securities or other appreciated assets.
A private foundation is a good option for individuals who would be considered high or ultra-high net worth. A typical funding contribution would be $2 million–$3 million to start. The foundation must distribute at least 5% of the value of charitable assets, as determined on a yearly basis. However, the donor/founder retains complete control over the funds and distributions. Many wealthier individuals fund these near or upon retirement.
For those who are interested in retaining control of their funds and maintaining a sense of volunteerism, private foundations offer many benefits. Many high-net-worth individuals will hire or have family members volunteer in the foundation in order to further charitable pursuits.
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2) Donor-Advised Funds
Donor-advised funds allow individuals to contribute to an existing organization and then direct the distributions to organizations and causes that the donor wishes to support. While the donor may advise on where to distribute the funds, they have ultimately given up control over the money. There is no requirement to spend the donated amounts within a set time period, though many donor-advised fund organizations require unused funds to revert to the general charitable purpose if they are not distributed within a number of years set forth in a contract.
Deductions for contributions to a donor-advised fund are limited to 60% of the taxpayer’s AGI for the taxable year. These are good options for wealthier individuals who want to be more intentional in their charitable contributions but do not want the burden of managing a full charitable entity.
3) Charitable Lead Annuity Trusts (CLAT)
With a charitable lead annuity trust (CLAT), the donor establishes a trust with one or more charities as named beneficiaries. For the life of the trusts, which may be the donor’s lifetime or a set number of years, the trust distributes a set annuity amount to the chosen charitable organizations.
Once the CLAT terminates (ends), the remaining assets in the trust pass the beneficiaries free of estate tax. The goal is to “zero out” the trust, meaning that the length of time the trust is in existence is long enough to distribute the full funding amount while also allowing large accumulation amounts that will be passed to the remainder beneficiaries.
Low interest rate environments are excellent for establishing and funding a CLAT. The lower the interest rate (sometimes called the 7520 or “hurdle” rate), the easier it is to zero out a CLAT while increasing the amount of accumulated wealth that will pass to the beneficiaries. This is because the trust funds will typically be invested and grow at a much faster rate than the low interest rate that must be distributed. This is a good strategy for someone who expects assets to grow in value.
These are excellent estate planning options for high-net-worth individuals who wish to support charitable causes but also transfer significant wealth to younger generations. CLATs are complex planning tools, but they can pay dividends for heirs at the end of the trust term — literally. And those dividends will not be subject to estate tax!
It is important for high-net-worth individuals to think carefully about what they are most comfortable with. While someone may have the wealth to set up a private foundation, they may prefer not to be involved on a day-to-day basis and opt to contribute to a donor-advised fund. Alternatively, someone who may have a taxable estate and would benefit from a CLAT may be more comfortable setting up a private foundation. Using one strategy does not stop the individual from using another if they have the means and the desire to do so.
These strategies will require additional steps to implement. Private foundations will require certain ongoing compliance, including filing a federal form 990 each year. Charitable lead annuity trusts require trust administration throughout the term of the trust and additional filings as well, including federal form 5227 for split interest trusts. There may also be state requirements as well.
All these are good options for more affluent individuals and will give more structure to individual charitable strategies. By providing more targeted ways of giving, firms that provide tax advisory services can maximize the impact of their clients’ philanthropic tendencies while reducing tax burdens over time. While tax benefits will not convince a client to give to charity, for those who are already charitably inclined, they can certainly be the (donated) cherry on top.
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